In the past year, the world has seen serious corporate malpractice on an unprecedented scale. Enron, Global Crossing, Xerox and Worldcom are just some of the American giants embroiled in scandal. All this has led to corporate governance becoming a leading new theme in business, giving rise to a plethora of books and articles. In the US, the situation has become so embarrassing to big business – and the nation – that President George W Bush has been forced to address serious reform. Earlier this summer, he accused company executives of undermining the integrity of American business by "breaching trust and abusing power."
With China's economic reforms and since its accession to the World Trade Organisation a year ago, corporate governance has become a hot topic in the People's Republic too. In recent months officials from the China Securities Regulatory Commission (CSRC) and the State Economic Trade Commission have been touring the country, carrying out indepth inspections of the corporate governance practices of China's 1,284 listed companies. In January, the CSRC published a code of corporate governance, which the inspectors use to measure actual practices. The code includes provisions for related-party transactions, which will affect most companies, since the majority of listed firms have considerable commercial and financial dealings with unlisted parent firms. The code also sets standards for independent directors. As of June 30, every listed firm is required to have at least two independent directors.
Centre stage of enterprise reform According to the World Bank and the International Finance Corporation (IFC) report Corporate Governance and Enterprise Reform in China: Building the Institutions of Modern Markets, the Chinese government has highlighted corporate governance as "the core element of the 'modern enterprise system'". It has, the authors claim, "moved to the centre stage" of enterprise reform. It is asking a lot for the country to embrace good governance when pillars of Western capitalism are collapsing. The report notes that "corporate governance scandals in emerging and developed markets indicate that there is no perfect corporate governance model." What are the challenges of convincing Chinese enterprises to adopt transparency and accountability, post-Enron?
James Brock, senior representative of German law firm Haarmann Hemmelrath in Beijing, believes the impact of Enron and other disasters has been "minimal" in China. The Chinese, he argues, "don't care much about what happens outside China. They don't believe accounting statements generally and are surprised Americans take them so seriously." Enron and Worldcom executives, Brock adds, if found guilty of deliberate fraud, "would be shot in China."
The scandals have done little either to hinder or accelerate the drive for good governance in Chinese business, in Brock's view. "The need for better transparency is and has been well recognised by the Chinese for some time and was a factor in their desire to impose WTO-type standards even if they had not entered the WTO," he explains. The Chinese, in fact, are more open to reform than the West has been. "I'm not sure Western systems are an improvement over Chinese systems," says Brock. "The impact of Enron has been so severe in the West because Westerners assumed their systems didn't need improvement. Chinese aren't burdened with that misconception."
Lawyer Mark Schaub of Chinese firm King & Wood in Shanghai agrees, and argues that local cases such as the diversified company Guangxia (Yinchuan), which local media said had inflated its annual profits, "have had a far greater impact than the US scandals." China has been trying to improve corporate governance, particularly in listed companies, for some time and efforts to introduce concepts such as independent non-executive directors began pre-Enron. While the collapse of Enron may bring smiles of self-satisfaction to the faces of some Chinese executives, Schaub does not believe it will trigger change in China. "Many Chinese, like many Europeans, are taking a certain pleasure in that the US consultants and lawyers are finally not always telling us that US GAAP [accounting principles] is the best and only system."
Brock says the key problem in China is the issue of ownership. "The vast majority of 'ownership' is by the state in some form, rarely in stock or defined shares," he explains. "Many managers and directors in Chinese entities can't tell you who or what agency actually owns how much of the entity they manage." Valuation is another difficult concept. "The Chinese idea of an audit is to count physical things and make sure they are still there – no estimate of replacement cost or value," he adds. "These are paradigm changes, ideas difficult for most Chinese managers and directors to understand pre- Enron and no less difficult to deal with now."
Shift in Asian attitudes
Jamie Allen, secretary-general of the Asian Corporate Governance Association, however, does believe that the effect of the US scandals has been to cause a fundamental change of attitude towards good governance across Asia. "People realise now that corporate governance really does matter. People realise that without good corporate governance, companies can go bankrupt." The concept has, therefore, become more "saleable," not less. "We are seeing people, who 12 or 18 months ago were not taking this seriously, now placing corporate governance at the top of their priority list."
The dean of the faculty of business and information systems at Hong Kong Polytechnic University, Professor Judy Tsui, hopes that the US scandals will have convinced the Chinese that "the financial reporting system and corporate governance regime in the Anglo-Saxon model is not likely to work effectively in the unique government- dominated ownership structure in China." But Tsui, who has been developing independent director training courses in China, believes translating all the talk about better governance into action will not occur overnight. For example, she says, "it will take time for effective enforcement and effective training for independent directors." The challenge ahead is to improve the quality and training of directors.
But Allen believes the requirement for listed companies to have at least two independent directors will not be as difficult for companies to meet, or for the authorities to enforce, as some people suggest. "The authorities should be capable of enforcing this, because it is very clear," says Allen. The challenge will be how seriously companies take it. "It is easy to appoint a few independent directors. The question is their substance."
Chinese companies that are trying to become global brands, such as China Telecom, PetroChina, Bank of China and Haier, are the ones that will develop independent directors with "more substance," says Allen. Jonathan Woetzel, director of McKinsey & Co in Shanghai, agrees, arguing that the interest in corporate governance in China is uneven and "not nearly where it should be." It depends on the type of company, he explains.
"Primarily, companies that are seeking an international listing pay attention to developing good governance, as they understand it could help them get a higher price from international investors. Only recently have domestically listed companies followed suit. This is partially driven by the regulator recently being more aggressive."
Shortage of talent
Some people believe the pool of talent to match the demand for independent directors is so small that it will take years for every listed Chinese company to appoint the required two directors. Not so, argues Allen. "The question of independent directors gets overplayed," he says. "Yes, there is a lack of good quality independent directors. But that's why the international Chinese companies are looking outside China. It makes sense." Bank of China, for example, has appointed Hong Kong businessmen Victor Fung and CC Tung, brother of Hong Kong Chief Executive Tung Chee-hwa, to its board, and retained lawyer Anthony Neoh as a senior adviser. PetroChina also has CC Tung, along with Italian businessman Franco Bernab.
Allen also points out that it is not only China that suffers a shortage of experienced independent directors – the concept is new for most countries in Asia. "Before the Asian crisis, only three markets – Hong Kong, Singapore and Malaysia – required independent directors."
One important factor is proper pay for independent directors, something that will depend on whether they are Mainland Chinese or not. "If you only pay US$10,000 a year, for four board meetings and various sub-committees, that's a pittance. If you pay well, the supply will increase," says Allen. Some critics warn, however, not to pay too much, since the more independent directors earn, the less likely they are to blow the whistle when they spot signs of corporate malpractice.
Shareholder activism, although still rare, is starting to emerge in Mainland China. In January this year, the Supreme Court said it would allow investors to sue listed companies for publishing false information. Although class-action lawsuits are still banned and cases are often politically sensitive, some action has already been taken. In August, the Harbin Intermediate People's Court in Heilongjiang province heard a case brought by shareholders against listed firm China is uneven and "not nearly where it should be". It depends on the type of company, he explains. "Primarily, companies that are seeking an international listing pay attention to developing good governance, as they understand it could help them get a higher price from international investors. Only recently have domestically listed companies followed suit. This is partially driven by the regulator recently being more aggressive."
Allen also points out that it is not only China that suffers a shortage of experienced independent directors – the concept is new for most countries in Asia. "Before the Asian crisis, only three markets – Hong Kong, Singapore and Malaysia – required independent directors." One important factor is proper pay for independent directors, something that will depend on whether they are Mainland Chinese or not. "If you only pay US$10,000 a year, for four board meetings and various subcommittees, that's a pittance. If you pay well, the supply will increase," says Allen. Some critics warn, however, not to pay too much, since the more independent directors earn, the less likely they are to blow the whistle when they spot signs of corporate malpractice.
Shareholder activism, although still rare, is starting to emerge in Mainland China. In January this year, the Supreme Court said it would allow investors to sue listed companies for publishing false information. Although class-action lawsuits are still banned and cases are often politically sensitive, some action has already been taken. In August, the Harbin Intermediate People's Court in Heilongjiang province heard a case brought by shareholders against listed firm Daqing Lianyi Petrochemical, for allegedly giving false information. In another case, the Yinchuan Intermediate People's Court agreed to hear allegations against Guangxia (Yinchuan) Industry.
In the same month, Shenzhen-listed ZTE Corporation, one of China's major telecoms equipment suppliers, announced it would consider a bonus shares issue in order to placate minority shareholders who threatened to vote against its planned Hshare offering. This offering amounted to 30 percent of the company's enlarged share capital, and was designed to finance its international expansion plans. According to Mainland investor protection rules, independent shareholders can vote on the issuance of offshore shares that amount to more than 20 percent of the company's capital base.
In another development, the CSRC accused Tianjin Capital's chairman, Ma Baiyu, of breaching the corporate governance code for listed companies, and identified six improper practices in the company. Tianjin Capital has been warned to improve its corporate governance standards by the end of the year, or pay a penalty. The CSRC claimed the company's directors had acted without authority in a case where external investments amounting to Yn4m had not been presented to shareholders for approval. Other faults included the fact that Ma is also vice-chairman of the parent company, despite the code's requirement that directors of listed companies are not allowed to hold management positions in other companies.
The implementation stage
China's next stage is implementation and enforcement, in Allen's view: "Allow the court system to work. There have been cases where shareholders have not been able to use it. Allow the market to function effectively. Have tougher penalising."
What is required, in the opinion of the IFC and the World Bank, is an effective system capable of "identifying weaknesses before they develop into systemic problems." The priorities for policy action now, the two organisations advocate, are developing market discipline and regulatory capacities to alleviate the "negative impact of dominant state ownership", as well as building an institutional investor base and strengthening the role of the banks. Only time will tell whether China can succeed in putting meat on the bone of corporate governance, and in putting the good words into action.
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